Periodicity concept – the business’ economic life is divided into artificial
time period to aid in making economic decisions by providing timely information
about the business.
Revenue and Expense Recognition Principles
Revenue is earned in the accounting period when the services are
rendered or the goods sold are delivered.
Expenses are recognized through:
1. Direct association of cost incurred and the earning of specific
items of income
2. Systematic and rational allocation – economic benefits are
expected to rise over several accounting periods and the
association with income can only be broadly or indirectly
determined.
Adjusting Entries
1. To reflect in the accounts information on economic activities that have
occurred but have not yet been recorded.
2. Assign revenues to the period in which they are earned, and expenses to
the period in which they are incurred.
3. To measure properly the profit for the period and to bring related asset
and liability accounts to correct balances for the financial statements.
4. Involves the changing of account balances at the end of the period from
what is the current balance of the account to what is the correct balance
for proper financial reporting.
5. Each adjusting entry affects a balance sheet account and a income
statement account.
Deferrals
The postponement of the recognition of :
•An expense already paid but not yet incurred
•A revenue already collected but not yet earned
Deals with an amount already recorded in a balance sheet account, the
entry therefore:
•Decreases the balance sheet account
•Increases an income statement account
Deferrals are needed in:
•Allocating assets to expense ( prepaid insurance, supplies,
depreciation)
•Allocating revenues received in advance to revenue to reflect
revenues earned during the accounting period (subscriptions)
Accruals
The recognition of:
•An expense already incurred but unpaid and unrecorded
•Revenue earned but uncollected and unrecorded
Deals with an amount unrecorded in any account
The entry would:
•Increase both a balance sheet account and an income statement
account
Adjustments for Deferrals
Prepaid expenses are assets that expires either with
•The passage of time
•Through use and consumption
If no adjustments are made:
•The assets will be overstated
•The expenses will be understated
•Owner’s equity in the balance sheet is overstated
•Profit in the income statement is overstated
Prepaid Rent (adjustment)
The accountant of Barbie Health and Beauty Specialist makes an adjusting
entry to record the expiration of the three months’ advance rent paid in July 1
for P21,000
Transaction
: expiration of one month’s rent
Analysis
: assets decreased. Owner’s equity decreased.
Rules
: decrease in assets are recorded by credits.
decrease in owner’s equity are recorded by
debits.
Entries
: Decrease in owner’s equity is recorded by a debit
to rent expense. Decrease in assets is recorded
by a credit to prepaid rent.
Rent expense
Prepaid Rent
7,000
7,000
After adjustment……
Prepaid rent
Jul 1
21,000
14,000
======
Jul 31
7,000
Prepaid Insurance …..
The accountant of Barbie Health and Beauty Specialist records the
expiration of one-twelfth of the company’s one-year insurance policy taken
last July 1 for P24,000
Transaction
: expiration of one month’s insurance
Analysis
: assets decreased. Owner’s equity decreased.
Rules
: decrease in assets are recorded by credits.
decrease in owner’s equity are recorded by
debits.
Entries
: Decrease in owner’s equity is recorded by a debit
to insurance expense. Decrease in assets is
recorded by a credit to prepaid insurance.
Insurance Expense
Prepaid Insurance
2,000
2,000
Supplies ….
Barbie discovered that she used up P500 worth of supplies during July
which she purchased for a total of P1,000. She makes the necessary
adjusting entry.
Transaction
: consumption of supplies
Analysis
: assets decreased. Owner’s equity decreased.
Rules
: decrease in assets are recorded by credits.
decrease in owner’s equity are recorded by
debits.
Entries
: Decrease in owner’s equity is recorded by a debit
to supplies expense. Decrease in assets is
recorded by a credit to supplies
Supplies Expense
Supplies
500
500
Depreciation of Property and Equipment
Buying long-lived assets like building, vehicles, computers or office
furnitures is prepaying for the usefulness of that asset that helps
generate income for the business.
Depreciation – allocation of the cost of the asset over its estimated useful
life.
Factors:
1. Asset cost – the amount paid to acquire the depreciable asset
2. Estimated salvage value – the amount that the asset can
probably be sold for at the end of its estimated useful life
3. Estimated useful life – the estimated number of periods that an
entity can make use of the asset
Estimating depreciation through the straight-line method
Asset cost
xx
Less: estimated salvage value
xx
Depreciable cost
xx
Divided by : estimated useful life
xx
Depreciation expense for each time period
xx
Note:
• asset is not directly reduced
•Reduction is recorded in the contra account accumulated
depreciation
•Contra accounts allow the disclosure of the original cost of
the asset
•Cost of asset less balance of contra account = book value of
the property and equipment
Vehicle and Equipment…
Barbie bought a van for P300,000 and hair steamers for P54,000
last July 1 & 2. She allocates a full month’s depreciation for
property and equipment bought on or before the 15th of the
month, otherwise, it is half-month’s depreciation. It is estimated
that the van will have a useful life of 5 years and a salvage value
of P30,000 while the hair steamers, 4 ½ years useful life without
salvage value.
Compute for depreciation expenses for the van and the hair
steamers.
Transaction
: recording depreciation expense
Analysis
: assets decreased. Owner’s equity decreased.
Rules
: decrease in assets are recorded by credits.
decrease in owner’s equity are recorded by
debits.
Entries
: Decrease in owner’s equity is recorded by a debit
to depreciation expense. Decrease in assets is
recorded by a credit a contra asset accounts –
accumulated depreciation
Depreciation Expense - Vehicle
4,500
Accumulated Depreciation-vehicle
Depreciation Expense - Equipment
1,000
Accumulated Depreciation-Equipment
4,500
1,000
Barbie Health and Beauty Specialist
Partial Balance Sheet
July 31, 2009
Property and Equipment (net):
Service Vehicle
P 300,000
Less: Accumulated Depreciation
4,500
Office Equipment
54,000
Less: Accumulated Depreciation
1,000
P 295,500
53,000
P 348,500
Allocating Revenues Received in Advance to Revenues
Receipt of cash for services or goods even before service is rendered or
goods are delivered. It is a liability for the entity and is referred to as
unearned revenue. Ex. Magazine subscriptions
Unearned Referral Revenues
On July 20, Barbie received a P13,500 prepayment for six future home
service. Since Barbie completed one of these visits in July, an adjusting entry
is made to reflect this.
Transaction
: recognition of income where cash is received in
advance
Analysis
: liabilities decreased. Owner’s equity increased
Rules
: decrease in liabilities are recorded by debits.
Entries
increase in owner’s equity are recorded by
credits.
: Decrease in liabilities is recorded by a debit to
unearned revenue. Increase in owner’s equity is
recorded by a credit to Service Revenue
Adjusting Entry:
Unearned Revenue
Service Revenue
P _______
P _______
Adjustments for Accruals
Accrued Expenses – entity incurs expenses before paying for them.
Accrued Salaries
Barbie records an expense for the salaries of the part-time employee
who earned P1,600 during the four days of July but will not be paid until
August 10.
Transaction
: accrual of unrecorded expenses
Analysis
: liabilities increased. Owner’s equity decreased
Rules
: increase in liabilities are recorded by credits.
decrease in owner’s equity are recorded by
debits
Entries
: Decrease in owner’s equity is recorded by a debit
to Salaries Expense. Increase in liabilities is
recorded by a credit to salaries payable.
Salaries Expense
1,600
Salaries Payable
1,600
Accrued Interest
Barbie’s P100,000 notes payable, which was signed on July 3 carries an
18% interest rate. Barbie uses the formula (for simple interest) below to
calculate how much interest expense accrued during the final twenty-eight
days of July.
Interest = Principal x Interest Rate x Length of Time
= P100,000 x 18% per year x 28/360 of a year
Transaction
= P1,400
: accrual of unrecorded expense
Analysis
: liabilities increased. Owner’s equity decreased
Rules
: increase in liabilities are recorded by credits.
decrease in owner’s equity are recorded by
debits
Entries
: Decrease in owner’s equity is recorded by a debit
to Interest Expense. Increase in liabilities is
recorded by a credit to interest payable.
Interest Expense
Interest Payable
P 1,400
P1,400
Note: at the end of July, Barbie owed the bank P1,400 for interest
in addition to the P100,000 loan
Accrued Revenue – the company may provide services during the period
that are neither paid for by the clients nor billed at the end of the period.
On July 31, Barbie went to Trixie’s home for a home service. Barbie mailed
the bill to Trixie on Aug 2 for P2,500. Barbie made an adjusting entry in
accordance with the revenue recognition principle.
Transaction
: accrual of unrecorded revenue
Analysis
: assets increased. Owner’s equity increased
Rules
: increase in assets are recorded by debits
Increase in owner’s equity are recorded by credits
Entries
: increase in asset is recorded by a debit to
accounts receivable. Increase in owner’s equity
as credit to Service Revenues.
Accounts Receivable
Service Revenue
2,500
2,500
Accrual for Uncollectible Accounts
The company made a credit sales of P1,100,000 in 2008 and prior
experience indicate an expected 1% average uncollectible accounts rate
based on credit sales. The contra account – Allowance for Uncollectible
Accounts has a normal credit balance and is shown in the balance sheet as a
deduction from Accounts Receivable. The adjustment will be:
Uncollectible Accounts Expense
_______
Allowance for Uncollectible Accounts
_______
If account is definitely uncollectible:
Allowance for Uncollectible Accounts
Accounts Receivable
_______
_______